ADIT Examination: Paper IIE - Malta Option

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1 ADIT Examination: Paper IIE - Malta Option QUESTION 1: 1.1) Participations Ltd Participations Ltd is domiciled and resident in Malta and thus taxable on its world-wide income. The participating holding definition is met given that the Maltese company owns the entire equity shares of Subsidiary Ltd. A) Bonus Shares Article 2 of the Income Tax Act defines dividends as including bonus shares as well. Bonus shares involve the capitalisation of the company's distributable profits. Despite the participating holding definition being met and the income derived is equivalent to dividends, the Maltese company cannot avail itself of the participation exemption (or 100% refund) IF the participating holding was acquired on or after 1 January The reason is that Subsidiary Ltd is not situated in an EU Member state. If it was acquired before 1 January 2007, then Participations Ltd could either: - Apply the participation exemption and not incur any Maltese Tax. Income is allocated to FTA; or - Have such income be taxed at the normal rates, allocate it to the FIA and then upon distribution to the shareholders (assuming deemed distribution orders do not trigger in) apply for a 100% tax refund. B) Dividend The same treatment exactly like a bonus issue explained in A). C Interest Payment Irrespective of the anti-abuse provisions, such income would never be exempt by virtue of the participation exemption. Assuming that such interest is of a passive nature, the company would have the following options: - Allocate it to the FIA and claim treaty relief (or unilateral) as long as there is evidence of tax paid abroad. In this case, upon distribution of dividends, the shareholders of Participations Ltd could claim a 2/3s refund of Malta tax payable. - Allocate it to the FIA and claim FRFTC (no need of foreign tax actually incurred). Once again 2/3s refund of the actual Malta tax could be claimed. - Allocate it to the FIA and do not claim any relief but shareholders could obtain a 5/7s refund. Obviously, should the interest income be viewed of a trading nature, it could be allocated to the MTA whereby 6/7s refunds could be claimed.

2 1.2) Initial Allowances In terms of Article 14 (i)(j) of the Income Tax Act on initial allowance in addition to the normal capital allowance could be claimed in the first year of industrial building or structure. The reason behind this was to provide a further incentive to purchase new capital assets. Prior to year of assessment 2002 this was applicable also to plant and machinery at the rate of 20% but as from YA 2002 this no longer applies. The initial allowance in respect of industrial buildings and structures (defined as also including hotels, but in terms of a British case it does not include warehouses) is worked at 10% on the cost during the first year. Always, the cost of industrial buildings or structures must not include the land element. Therefore, the total allowances claimed in the first year of an industrial building or structure is 12% (10% initial allowance and 2% capital allowance). 1.3) Frust Ltd Frust Ltd is not incorporated in Malta and given that it is not even effectively managed in Malta it is neither domiciled nor resident in Malta. Hence, Frust Ltd may only incur Maltese tax in respect of Malta source income. The Branch would also not be domiciled or resident in Malta but in terms of the Companies Act it would be required to register as an Overseas Company within one month of establishing a place of business in Malta. Such registration would still however, not make the Branch resident or domiciled. The Branch will derive two types of Malta source income: 1. Trading Income This income is subject to the Maltese Corporate Tax Rate and is allocated to the MTA. Upon any distributions of such income by the company to its shareholders, the latter may claim a 6/7s refund of the Malta tax paid. 2. Interest on Bank Account This income is sourced in Malta and hence by default is also taxable in Malta. It is not possible for any of the following to apply: a. The exemption of Article 12(1)(C)(i) of the ITA could not apply since such interest is related with a permanent establishment situated in Malta (the branch). b. Tax cannot be withheld at 15% in terms of the investment income provisions, since the beneficiary of the income is not a Recipient for the purpose of such provisions. Therefore, such bank interest could be allocated to the MTA, but this time upon a distribution, the shareholders could avail themselves of a 5/7s refund. 2

3 QUESTION 2: 2.1) Bahrija B.V. In terms of LN 244 of 2004, Malta grants an income tax exemption in respect of the following shipping related income: (A) (B) (C) The income of a shipping organisation from the carrying of shipping activities. Any gains derived from the transfer, redemption, liquidation or redemption of shares in a shipping organisation. Income derived from the granting of credit to finance shipping activities. The income derived by Bahrija B.V will fall under exemption (A) above. However, the application of such exemption from income tax and the levy of a tonnage tax instead is only possible if a number of conditions are satisfied: - the entity must be provided with a license to act as a shipping organisation (in terms of the Merchant Shipping Act) - such a license is issued as long as the organisation carries out shipping activities in terms of Article 842 of the Act, which include: i) ownership, operation (including chartering) and administration of tonnage tax ships registered in Malta or in/outside of the community (subject to certain conditions). ii) iii) the holding of shares or interests in entities carrying shipping activities. raising capital by issuing shares or by borrowing to finance its shipping activities or of other entities within the group. Bahrija B.V. should then be able to obtain shipping organisation status and hence avail itself from the exemption of income tax. A tonnage tax would have to be paid based on the tonnage of the vessel. Bahrija B.V. would not even be required to submit a tax return but a tax declaration in lieu of such return is necessary (unless it derives income which falls outside the income tax exemption). Should Bahrija B.V. not decide to register the ships in Malta (hence the vessels remain non-maltese flagged) the aforementioned treatment would still apply subject to certain conditions. 3

4 2.2) A. Double Tax Treaty Relief Gross Foreign Income 1, Deduction (400)_ 1, Malta tax payable 35% D.Tax Treaty Relief (111.11) Actual Malta Tax Lower of: or 1, x _ 1, or B. Unilateral Relief Exactly like treaty relief A above: Gross Foreign Income 1, Deduction (400)_ 1, Malta tax payable 35% D.Tax Treaty Relief (111.11) Actual Malta Tax C. FRFTC Net foreign income 1,000 FRFTC (25%) 250 1,250 Deductions (400) 850 Malta Tax Payable (35%) % check % (No optimisation needed)

5 FRFTC cont... Malta Tax payable FRFTC (250) Actual Malta Tax ) In order for the FRFTC to be availed from, the following conditions must be satisfied: 1. The income falls to be allocated to the FIA 2. A Maltese registered auditor issues a certificate stating that such income actually falls to be allocated to the FIA. 3. The company must be empowered (through a clause in its M&A) that it could receive income to be allocated in the FIA. 4. The company availing itself of it must be registered in Malta during the year immediately proceeding the year of assessment. And once the company would have availed itself of FRFTC, the only possibility for the shareholder would be to claim a 2/3s refund upon the distribution of such profits. Shareholder 1-2/3s refund on 50% of Shareholder 2-2/3s refund on 50% of Total tax refund to be claimed QUESTION 3: 3.1) Fondi plc The fund in question involves a prescribed fund since the majority of the underlying assets are situated in Malta. A) Income related with immovables This income is taxable in Malta but the rates may vary: - In the case of sales of immovable situated in Malta, the default Article would be 5A where tax is withheld at 12% on the transfer value. However, if it is possible to opt out of 5A this could be treated as normal trading income. If such sales are taxable in terms of A.5A, the income would be allocated to the FTA. Any distributions made from the FTA would be final and neither the full-imputation refunds nor ITMA refunds would be possible. If the sales fall outside the scope of A.5A, the income would be allocated to the IPA in respect of which it is possible to claim full-imputation refunds but not ITMA refunds. - Rental income would be allocated to the IPA, in respect of which the shareholders could only avail of full imputation credits but not ITMA refunds B) Income from Cypriot Company Article 12(1)(s) of the ITA exempts any income derived by a CIS other than income from immovable property situated in Malta or investment income as defined in Article 41A (a). Hence, such dividend would not be subject to any taxation and would be allocated to the untaxed account. 5

6 Distributions from the untaxed account to persons defined as "recipients" (which includes Maltese resident individuals) would be subject to a 15% withholding tax. However, such tax is not final and if any of the recipient shareholders' total taxable income falls below the taxable threshold he/she could claim a credit. 3.2) VAT a) Outside Malta b) Malta c) Outside Malta (B2B) d) Malta (B2C) e) Malta f) Malta g) Outside Malta h) Where the transport takes place proportionate to the distance covered i) Outside Malta j) Outside Malta 3.3) The directive eliminates withholding taxes on interest or royalty payments made between associated companies in different member states. Malta charges no tax on outbound payments of Royalties or interest which is in line with the directive. This exemption (A.12(1)(c)(i)) applies notwithstanding the non-resident recipient not being associated with the payor. However, A.12(1)(c)(ii) is subject to some limitations, because firstly the income cannot be derived from trade or business or from a permanent establishment. Secondly, the beneficiary cannot be ordinarily resident and domiciled in Malta. Contrary to A.12(1)(c)(ii), the directive still applies when interest or royalty are derived from trade or a permanent establishment in another EU member state. 3.4) Mr Borg Mr Borg is taxable on his worldwide income. The same will also apply to Borg Holdings Ltd since it will be incorporated in Malta. The satisfaction of the participating holding definition and also of one of the anti-abuse provisions (resident in Cyprus - EU MS) means that the Maltese company may apply the participation exemption or the 100% refund. However, should this be the case the deemed distribution order in terms of Article 43(b)(c) of the ITA will trigger in. This would mean that Mr Borg would be deemed to have received dividends on which he incurs tax in terms of the investment income provisions on the net dividends and the net refunds. This means that rather than enjoying a 0% effective tax rate, Mr Borg's effective tax rate would rise up to 38.25%. 6

7 QUESTION 5: 5.1) Patents Ltd The Maltese SPV will by default be domiciled and resident in Malta. The provision of a registered office helps in substantiating the fact that company is resident in Malta, but caution must be taken to ensure that the key strategic decisions of the company are actually taken in Malta. Otherwise the company may be deemed to be dual resident. However, assuming the above, the company will be taxable on its worldwide income. Article 2 of the ITA defines passive interest or royalties as income not derived directly or indirectly from trade. In this case, it is very likely for the company to be deemed carrying a trading activity. Moreover, it is also being assumed that the income is not related with a permanent establishment that the company may have outside Malta. Should this be the case, this income would be allocated to the FIA. On the other hand, if the income is not related with a PE outside Malta, the income would be allocated to the MTA. Upon any distributions from the MTA, the non-res shareholders could claim a 6/7s refund of the Malta tax. It is not possible for this income to fall within the scope of A.12(1)(c)(i) exemption since it is derived from trade and the beneficiary is resident in Malta. Nevertheless, Article 12(1)(v) provides a further exemption in respect of royalty income which applies irrespective if from trade or if derived by a resident person. This is however, only applicable to qualifying patents and as long as the intellectual property would be used for the pursuance of the economic activity of the person paying the royalty. Since the clients are not taxable persons for VAT purposes, the intellectual property would not be used for their economic activity. Hence, exemption of Article 12(1)(v) is still not applicable. Would this have been the case, such exempt income would have been allocated to the FTA. 5.2) Malta SICAV A. Malta Gov't Bonds This income consists of investment income as defined by the investment income provisions. Rather than at the normal 15% tax would however be withheld at 10%. Such income would be allocated to the FTA. B. Bank Interest Assuming that such interest does not accrue from a bearer account, such income also falls under the definition of investment income. This time, tax would be withheld at the default 15%. Such income is allocated to the FTA. C. Interest from a Swiss Bank A/C Since this income is not paid through an AFI it is not part of investment income. Hence, in terms of Article 12(1)(s) of the ITA, no tax is payable in respect of such income. This income will be allocated to the Untaxed Account. D. Rental Income This involves income derived from immovable property situated in Malta, and hence the exemption of article 12(i)(s) will not apply. Such income is taxable at the normal 35% rate and allocated to the IPA. E. Gains From Transfer of Prop. in Bulgaria Given that this immovable property is not situated in Malta, it still falls within the scope of 12(1)(s) exemption. Hence, no tax is paid on such income and it is allocated to the Untaxed Account. 7

8 F. Dividends The dividends are derived from a Maltese resident company, so in terms of the full imputation system no further tax would be charged. However, as a company, the SICAV would still be required to show the dividend income at gross and then taxed at 35%. Such income should be allocated to the same tax account from where it is paid. 5.3) TALGAS Ltd TALGAS is domiciled and resident in Malta so it is taxable on its worldwide income. A. Provision for Contingent Liability Provisions cannot be deducted for tax purposes because they are not incurred for the production of income. Like depreciation, provisions are an estimate which may not even have been necessary. B. Interest on Warehouse loan Article 14(1)(a) of the ITA states that if interest is incurred for the purpose of acquiring income, then it should be deducted. Hence, such interest could be allowed. C. Cost of Warehouse This cost is of a capital nature and hence it cannot be deducted against income. Note that, warehouses are generally not even viewed to be part of industrial buildings or structures (British case) and hence not even a 2% capital allowance could be deducted. D. Take - or - Penalty Generally fines or penalties are not taken as allowable since they are not deemed to be incurred in the production of income. However, in a particular BSC case, the appellant was allowed to deduct damages towards others. In fact, such penalties arise specifically because of the level of trade carried out and hence it is incurred in the production of income. This expenditure is therefore deductible. 8

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